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Asia Refining Margins
Taking a deeper look at Reliance Industries
Four- to five-year cycles – being challenged
For the past 18 months we have referenced the 4-to 5-year refining cycle (Figures
9-12). These refining cycles make sense as it takes 3-5 years to build a refinery.
Year 2010 was the second consecutive year of below-average global refining
margins. At our May 2010 Deutsche Bank Asia Conference, Wood Mackenzie
suggested sub-US$5/bbl Sing complex margins through 2014E. We recently set
our Sing complex margin at US$6.0 and 6.60/bbl for 2011-12E, respectively.
Reliance Industries (RIL – Buy, target price INR1,150/share)
In this piece we will take a closer look at our strong Buy rating on Reliance
Industries. RIL has been the worst-performing refining and petrochemicals stock in
the region despite being the most complex regional refiner (Figure 2). A decline in
natural gas production at KGD6 and dry wells in KGD9 have been the key reasons
for this underperformance. In a deal with BP, RIL recently agreed to sell a 30%
stake in 23 of its E&P blocks in India for US$7.2bn, plus an additional US$1.8bn
payment based on exploration success. Completion of the proposed deal could
accelerate RIL’s exploration programme targeting the prospective MND4, KGD9
and KGD3 blocks. BP’s technical expertise for deepwater exploration and
development should benefit Reliance’s efforts in this area. We believe the deal
sets the floor for RIL’s E&P valuation, reducing some uncertainty on this front.
Strong downstream margins should benefit RIL
Driven by strong global demand and higher utilization rates, we expect
downstream margins to be robust in FY12-13. With more than two-thirds of its
operating profit coming from refining and petrochemicals, RIL should be a key
beneficiary of this trend. RIL is the largest polyester and fourth largest PX producer
in the world. It also has the largest single-location refining complex in the world
with a capacity of 1.24m bpd. We forecast RIL’s GRM at US$9.4/bbl for FY12
(year-end March 2012) and US$9.8/bbl for FY13. We rate RIL a Buy with a target
price of INR1,150 implying 19% potential upside to the current market price.
RIL valuation and risks
We show the stock trading at 13.7x FY11/12E earnings, 7.6x EV/ EBITDA and 1.9x
book value with ROE of 14%. Book values and ROEs of Asian E&P companies are
trading at an average 2.5x P/B with ROEs of 20%. We suspect that the recent
underperformance of RIL’s upstream natural gas business has been weighing on
the stock’s performance and that anticipated improvement in RIL’s E&P business
will act as the next catalyst for share performance. The principal risk to our Buy
rating on RIL would be continued underperformance of its E&P business.
Asia refining valuations and risks
We use historical P/B values to determine where we are in the cycle and P/B to
ROEs to judge relative value among Asian refineries. We also use DCF models to
value our refiners. Higher complexity deserves higher multiples. Taiwan multiples
are higher than most Asian markets given the retail investor base. Looking full
cycle (1998-2007), we see the Asia P/B valuations trough to peak of 0.7x to 3.4x.
The principal risk to the Asian refiners is the prospect of slower global GDP
growth, leading to increased spare refining capacity and lower utilization rates.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Asia Refining Margins
Taking a deeper look at Reliance Industries
Four- to five-year cycles – being challenged
For the past 18 months we have referenced the 4-to 5-year refining cycle (Figures
9-12). These refining cycles make sense as it takes 3-5 years to build a refinery.
Year 2010 was the second consecutive year of below-average global refining
margins. At our May 2010 Deutsche Bank Asia Conference, Wood Mackenzie
suggested sub-US$5/bbl Sing complex margins through 2014E. We recently set
our Sing complex margin at US$6.0 and 6.60/bbl for 2011-12E, respectively.
Reliance Industries (RIL – Buy, target price INR1,150/share)
In this piece we will take a closer look at our strong Buy rating on Reliance
Industries. RIL has been the worst-performing refining and petrochemicals stock in
the region despite being the most complex regional refiner (Figure 2). A decline in
natural gas production at KGD6 and dry wells in KGD9 have been the key reasons
for this underperformance. In a deal with BP, RIL recently agreed to sell a 30%
stake in 23 of its E&P blocks in India for US$7.2bn, plus an additional US$1.8bn
payment based on exploration success. Completion of the proposed deal could
accelerate RIL’s exploration programme targeting the prospective MND4, KGD9
and KGD3 blocks. BP’s technical expertise for deepwater exploration and
development should benefit Reliance’s efforts in this area. We believe the deal
sets the floor for RIL’s E&P valuation, reducing some uncertainty on this front.
Strong downstream margins should benefit RIL
Driven by strong global demand and higher utilization rates, we expect
downstream margins to be robust in FY12-13. With more than two-thirds of its
operating profit coming from refining and petrochemicals, RIL should be a key
beneficiary of this trend. RIL is the largest polyester and fourth largest PX producer
in the world. It also has the largest single-location refining complex in the world
with a capacity of 1.24m bpd. We forecast RIL’s GRM at US$9.4/bbl for FY12
(year-end March 2012) and US$9.8/bbl for FY13. We rate RIL a Buy with a target
price of INR1,150 implying 19% potential upside to the current market price.
RIL valuation and risks
We show the stock trading at 13.7x FY11/12E earnings, 7.6x EV/ EBITDA and 1.9x
book value with ROE of 14%. Book values and ROEs of Asian E&P companies are
trading at an average 2.5x P/B with ROEs of 20%. We suspect that the recent
underperformance of RIL’s upstream natural gas business has been weighing on
the stock’s performance and that anticipated improvement in RIL’s E&P business
will act as the next catalyst for share performance. The principal risk to our Buy
rating on RIL would be continued underperformance of its E&P business.
Asia refining valuations and risks
We use historical P/B values to determine where we are in the cycle and P/B to
ROEs to judge relative value among Asian refineries. We also use DCF models to
value our refiners. Higher complexity deserves higher multiples. Taiwan multiples
are higher than most Asian markets given the retail investor base. Looking full
cycle (1998-2007), we see the Asia P/B valuations trough to peak of 0.7x to 3.4x.
The principal risk to the Asian refiners is the prospect of slower global GDP
growth, leading to increased spare refining capacity and lower utilization rates.
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